Outsourcing Payroll? Fraud Happens and What to Do to Prevent It

  • Outsourcing payroll: Do you know if you outsource your payroll, you are still held liable for all payroll taxes due? Many owners and corporate officers believe that once they outsource payroll the responsibility for submitting payroll taxes and filing payroll reports resides with the payroll company.  That is not true.  The IRS and other government revenue collecting agencies hold the owner(s) and corporate officers liable for any unpaid payroll taxes, improperly filed payroll reports, or failure to file payroll reports.

    Robert Woods published, on Forbes, an article that underscores how officers are held liable. In his article “CEO Gets 7 ½ years Prison over employment taxes, owes $21M In Restitution.” Mr. James Douglas Pielsticker, former CEO of Arrow Trucking Company diverted company money owed for payroll taxes to his own personal bank account.

    He purchased luxury items such as a Bentley and a Maserati and paid for a wedding. Now he faces 71/2 years in prison and owes $21M in restitution.

    This is just one of the latest cases in payroll fraud. We highlight three other cases of fraud below.

    Common Payroll Practice Can Hurt Your Cash Flow

    When outsourcing payroll understand a common practice for payroll companies is to impound funds.  This simply means they withdraw all payroll expenses including payroll wages and all payroll taxes when they process your payroll.  

    They transfer the monies from your account to their account, collecting interest on it, until it is time to make payments. At any given time a payroll company can have hundreds of thousands of dollars to billions of dollars in their account accruing interest.  In Paychex’s most recent financial statement, just released last month, they reported revenue of over $41 million in interest income just from impounded funds.  The number is even larger for ADP.

    Most small businesses are setup as monthly depositors.  This simply means that you do not have to deposit payroll taxes (federal income taxes withheld, SS tax, Medicare taxes and many state and local taxes) until the 15’th of the following month.  For example, for a monthly depositor, payroll taxes would not be due until September 15th for any wages paid in August.

    If you are looking to manage your cash flow, when outsourcing payroll, using a company that impounds funds does not provide you with that flexibility.

    Loss of Accountability with Impounded Funds

    When funds are moved from your bank account to a vendors bank account you loose visibility and cannot readily track payments made to regulatory agencies.  How do you know or track your IRS or state tax payment if it is being sourced from an account you do not have access to?  

    The IRS published a list of examples of recent companies and individuals that have been prosecuted because the owner(s) or person(s) responsible for payroll committed fraud and covered their tracks.  These are just three of many.  You can find a more comprehensive list of companies and employees committing payroll fraud here.  Outsourcing Payroll Infographic IRS Cases Payroll Tax Fraud

    1. Paycare, Inc.

    An owner of Paycare, Inc., located in Los Angeles, California, was sentenced to 37 months in prison and ordered to pay $1,873, 617 in restitution.  The owner pleaded guilty to failure to pay federal payroll taxes intended for the IRS.  During 2009 and 2010, Paycare, Inc. prepared quarterly tax reports for at least 15 different clients for which they failed to account for and pay to the IRS the full amount of taxes owed by their clients. The payroll company collected the entire amount of taxes due, but diverted a  portion of the money for his own personal use.

    2. Owner of Maintenance and Construction Company  Sentenced to 12 months in Prison 

    The owner of a maintenance and construction company located in New York was sentenced to 12 months in prison, 3  years supervised release  and ordered to pay $1,593, 414 in restitution and a $60,000 fine. From 2001 through 2011, the owner owned and operated several construction and maintenance companies. As President and owner of those companies, it was his responsibility to withhold payroll taxes from his employees, make payments to the IRS on behalf of his employee and pay the employers portion of payroll taxes. The owner accumulated over $1.7 million in payroll taxes owed but never paid the taxes. The owner instead used the payroll taxes to pay for his own personal expenses.  During the course of the investigation, the investigators found the owner made false statements to the IRS. 

    3. Owner of North Carolina Payroll Company Sentenced for Fraud and Money Laundering

    Arthur S Weiss, owner of a professional employer organization, was sentenced to 185 months in prison and ordered to pay more than $7 million in restitution to victims.  His company provided payroll-related services to business clients.  For his business clients he agreed to pay the employees, withhold and remit federal and state payroll taxes, prepare and file the federal and state employment tax returns and provide workers compensation insurance.  Although he paid the employees and withheld the taxes, he did not submit over $4 million in payroll taxes, instead keeping them for his own personal use.  

    These are just three examples of payroll companies or an employee stealing from the business or businesses and employees they were working with and for.  As a business owner or officer of the company, here are a couple of things that you should do when outsourcing payroll to prevent this from happening to you:

    1. Don’t let your payroll company impound taxes.  Impounding is a common practice in the payroll industry.  Payroll companies pull out all your funds from your bank account (including all your payroll taxes) and deposit it into their bank account.  They make money on the “float” i.e., interest from when the time the money is pulled from your account to when they have to make the deposit.  

    When you allow a company to impound you have no bank record transaction to confirm the taxes were paid.  With our clients we setup payments so the money is moved from the client’s bank account to the revenue collecting agency.  There is always visibility and the bank transactions are recorded in the client’s bank account as verification that tax payments were actually made.

    2. Request copies of verification that taxes were paid.  Sign up for access to the Electronic Fund Transfer Program (EFTPS).  It is available free from the Treasury Department and gives employers on-line access to their payment history based on their EIN number.  It allows a company to verify that their payroll vendors is making the scheduled tax deposits.  

    3. Follow-up on all notifications received by the IRS or any revenue collecting agency.  All of them are time sensitive and must be dealt with immediately.  If your payroll vendor has “taken care of it” ask for confirmation.  Don’t hesitate to speak with the IRS even if you believe the matter was resolved or taxes were paid.  But also remember the IRS and other agencies do make mistakes.  It is not uncommon for us to respond to an issue of a tax payment because of an error on the part of the revenue collecting agency. 

    Finally, be wary and research a payroll company when outsourcing payroll. There are several benefits for going with a small payroll company over a large one but check references, follow-up on tax payments to insure they are made (this is true for both large and small payroll companies) and  if a notice is received follow-up with the notice. A notice from a revenue agency may be your first sign of payroll when outsourcing payroll.


    Payroll Tax Guide Ebook